Main Street Lending: What Your Bank Needs to Know

April 27, 2020 Jim Young

In this week's episode, Dallas and Jim talk about Main Street Lending. It's the proposed next set of federal emergency lending programs, but it's been somewhat overshadowed by PPP.

We go through some different uses cases for the program, the controversy around SOFR, and how banks are trying to navigate all the complexity. 



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Jim Young:

Hi and welcome to The Purposeful Banker, the podcast brought to you by precision lender where we discuss the big topics on the minds of today's best bankers. I'm Jim Young, director of content and precision lender and I'm joined again by Dallas Wells, our EVP of strategy.

Today's topic is the Federal Reserve's Main Street lending program. It's obviously massively important to commercial banks and their clients, but because things are coming fast and furious for everyone involved, there are a lot of questions about it, so we're going to try to answer a few of the most important ones in today's podcast.

Dallas, thanks for coming on again.

Dallas Wells:

You bet. Thanks Jim.

Jim Young:

All right, well just start us off here and I have in my notes with a quick overview of Main Street loan facilities. I don't know if click is as an option here, but at least can you give us an overview?

Dallas Wells:

Yeah, I'll give you the quick version. Rather than read the Federal Reserve term sheets to you. I think everybody's had plenty of that kind of stuff over the last few weeks. So the one disclaimer here is, we're doing this based off of the original announcement of the programs. There was a comment period that closed on the 16th of April and so far as we record this, there's been crickets from the federal reserve on a response to that.

But the assumption within the industry is that there will be at a minimum some clarification and potentially some program changes. So the quick overview as we stand today is that the Main Street lending programs are a total of $600 billion. So of note that's nearly doubled the size of the PPP program that has been all over the news. And so $600 billion, it is aimed at slightly larger businesses than PPP.

The minimum loan size is $1 million. So this is really aimed at kind of middle market borrowers and this one's actually a loan, so we'll get into that in a little bit. But this one does have to be repaid. The quirky thing about this one, I say quirky just because it's a new thing for the federal reserve to do. Banks will retain 5% of the balances that they originate. They will sell 95% of that exposure to a special purpose vehicle that the federal reserve is setting up.

So the Federal Reserve will be taking on true credit risk, just like the banking industry with this program. And that's a first for the federal reserve and has gotten surprisingly a little press with everything else that's going on. So there's two different versions of these. There's a new loan facility, there's an expanded loan facility where you can basically spin up a new tranche on the existing debt with a customer.

Payments are deferred for 12 months. So the idea is to get cash into the hands of middle market borrowers, middle market businesses so that they can survive through the worst of the pandemic. And just like with the PPP, hopefully it keeps some people employed by staying liquid through the toughest times. So that's the abridged version.

Jim Young:

So you mentioned PPP and how much that's been in the news, and I don't know if this is federal emergency loan program, fatigue on the part of the media or what, but it feels like or maybe it's fatigue on the part of me from how much I'm reading on it, but it feels like this main street program, which is large, as you mentioned, bigger in size and scope than PPP has gotten a lot less press. Why do you think that is?

Dallas Wells:

I think there's two major reasons for that. Number one, PPP is unlike anything we've seen in that it's forgivable, 100% forgiveable. The criteria for it being forgiven is pretty lax. So it's become kind of this stampede, like a land grab for this free government money. You combine that with it's first come first serve, the first tranche went really fast. We're right in the midst of starting a second round of it.

The industry struggled to get it out the door so there's been all kinds of reasons that it would be in the press just because it's money that doesn't necessarily have to be paid back. The other aspect of it is, and I think that's what's really starting to come out over the last few days, is it was truly aimed at small businesses.

So there's some, I would almost call it moral high ground where it's kind of Americana and mom and apple pie to loan $50,000 to the local hardware store or to the local cafe and you can see that in that because of some of the language in PPP, there were some larger businesses that were able to qualify for and get funding. So Ruth's Chris Steakhouse, Shake Shack, there's a whole list of publicly traded companies that fit the criteria, went to their banks, got the loans and that has not been received well.

So I think bankers are tiptoeing into main street because it is aimed at some bigger businesses than actually on the expanded version of the facility, the size can go up to $150 million. So some of these can be pretty sizable businesses. You're talking up to 10,000 employees up to two and a half billion dollars in annual revenues. So good size companies that are going to be recognizable and this'll have the stigma attached to it of bailing out some companies that maybe don't have the same moral high ground as the local hardware store.

So I think there will be some those two factors, the fact that it has to be repaid and that it's aimed at bigger businesses meaning that this one will probably be a little quieter, but in the long run, perhaps more important to the industry.

Jim Young:

You mentioned, and I don't want to go too far into this rabbit hole, but you mentioned bankers, a lot of them have taken a lot of heat for essentially giving out money to candidates that are qualified for that money and whether or not they should have been qualified as not really for a bank to determine. And also in some of those cases, very valuable clients who if you say no to them are going somewhere else for that money for which they'll qualify.

So that's one reason why I could see why bankers might be hesitant about whatever the next federal program that comes along but what are some other reasons why we're hearing a little bit or sensing some hesitation from bankers about using main street programs.

Dallas Wells:

Yeah, so part of it is just the mechanics of it. So again, this could be the stuff that changes a little bit but the fact that the banks are retaining 5% of the exposure and the new facilities are designated in the term sheets to be unsecured. So unsecured new debt to a borrower that by definition is in trouble, makes banks a little queasy.

So through the Federal Reserve has taken on the the vast majority of the additional exposure, but there is new money out the door that you're on the hook for and you have to service the full amount. So it's still your customer kind of your baby to go through the workout, which is going to be its own set of issues when those things start to happen. So and also just the mechanics of how do you sell that piece to the federal reserve?

How do you make sure that it qualifies and the PPP program was difficult enough but it was with the SBA, that's a process that a lot of banks are familiar with and getting SBA guarantees and closing them through the SBA there's a mechanism for that. Selling to this SPV that has yet to be created and the fed for the first time stepping into that role, we don't even know how these things are going to clear or what the criteria are going to be.

How is it going to be decided that that deal actually qualified and the fed will send you money for it. So that's the biggest one is just being uncertain about how it's going to work. The second piece of it is a little more in the weeds but may end up actually being the bigger issue and that is that these things are required again under the current terms that are out there required to be priced over SOFR.

So the new overnight index that's being pushed pretty hard by the fed in particular to replace LIBOR. This feels like a shot across the bow. That's how one banker put it to me of the fed saying, y'all been dragging your feet on using SOFR you have to right, we're going to back you into the corner on this and make you do it and the bankers responses is I get the intention.

Our systems literally cannot do it. We cannot process loans that are priced over SOFR. I won't get into the why's of that. It's calculating interest and arrears on this new index that doesn't have a proper term structure and things like that. The systems can't do it. It's not easy to get the systems updated to be able to do it.

So there's a few banks that have said, look, if it has to be so SOFR we literally can't participate no matter how much we want to. Now I find that hard to believe that if you've got some bad credits where this is the way that you jar them is through a program like this and there's many millions of dollars potentially at stake, I'm guessing you find a way to work around it but it's a real sticking point and it's one that the industry is really pushing hard to get changed before the program officially gets turned on.

Jim Young:

Yeah, and I can understand also some of the frustration and the other side of it, which is yeah, maybe fair to say some banks have dragged their feet on SOFR but also fair to say that the deadline is not here, but then in a way this program is essentially treating it like, oh yes it is. So, and just as a small data point, but we had on the day of this recording, Gita Thollesson and Greg Demas hosted a webinar basically looking at looking at the market and a bunch of different factors with what's going on with COVID.

And one of the questions I asked to the webinar registrants was what percent of your book right now is priced to SOFR? Again, don't know exactly who responded to it and it's not pure representative of banking in America, but the percentage was zero.

Dallas Wells:

I'm guessing for the industry it rounds to zero, right?

Jim Young:

Yeah, exactly.

Dallas Wells:

As we were rolling out some software changes to accommodate this, one of the engineers asked, well can we just make this contingent on these suggestions will pop up if they have SOFR as an available index on that product type. So we just did a quick check how many of our banks even have, it's in our system, we've had it available for a while, but how many have it turned on for products that are live in production?

The answer was zero. Nobody had it turned on. One bank looks like they've been testing it a little bit. That was about it. So that means that even sort of tangentially related systems like ours where we have the easy ability to do the math on it, that's a whole other thing where we have to say, by the way, you got to go turn on SOFR in our system and in your core system and everywhere else to be able to actually use those things.

So there are certainly some logistics on top of all the other COVID19 related difficulty and economic difficulty and the timing of this, it seems like an unreasonable wrinkle to throw in that isn't really necessary other than to say, told you we weren't kidding so maybe it'll get changed. And the fact that it was in there for a couple of weeks serves as the shot across the bow, but we'll see.

Jim Young:

Yeah, all right, well, so let's assume then though that you're going to go ahead and bite the bullet or you're going to push ahead and use SOFR on this, what are some potential use cases? Can you kind of walk me through a couple of examples for main street loans?

Dallas Wells:

Yeah, so I think first and foremost, my guess is that this gets treated as a workout option. So if you, let's look at a hypothetical middle-market type relationship. Maybe you've got $10 million outstanding to a borrower and they're in real trouble. So they're going to have trouble making payroll, covering rent, covering utilities, and staying current on their debt. So you're about to have some past due debt. They've asked for forbearance or they've asked for cash to help through tough times.

This is a way to get them some liquidity in hand. The borrowers have to make, they have to attest to the fact that they will make best efforts to retain employees. It's not a requirement. So there's no like you have to maintain payroll, it's just that you have to do your best to maintain payroll. The other interesting thing is that there's language in the program that says you can't pay off other debt before you pay off the main street facility except for mandatory principal payments.

So the way I read that, if I'm a banker, I say, well great, I can make them, in this case our $10 million that we have outstanding, let's go get them a $5 million main street loan. The fed will take 95% of that exposure. So for 5% of that, I can get them a whole bunch of liquidity in hand. There's no payments due on that for the next year and they can use a good chunk of that money to make principal payments to me along the way so they can keep themselves current and hopefully in a year get to the other side of the worst of this and they can resume.

So the math with the bankers will be doing is, I add a little bit of exposure for a hopefully much reduced probability of default because we just get them liquid and we get them past the worst of it where at a minimum maybe they can reopen their doors. And they can get their employees back in the warehouse or on the manufacturing floor and the restaurant, whatever we're talking about.

They can function a little bit, they'll have a higher debt load to carry, but it's reasonable interest rates, pretty flexible terms. And they've got a year where you can basically kick the can down the road at the fed's expense, at the feds, additional prior risk instead of your own.

Jim Young:

Gotcha. All right. Feels like we're talking a lot about de-risking and that sort of thing, which makes a ton of sense. This isn't PPP where it's like, hey, this is it boom and you send it through. What is the role of profitability in this?

Dallas Wells:

Yeah, so as you alluded to there, the terms are, some of them are set in stone and there's a few places where you've actually got some room to negotiate. So I think the intent is that you can make a profit on me. So I'll go through the highlights of this, again subject to change, but the way we see it right now.

The borrowers pay 1% origination fee on this money, that's pretty steep. That's pretty far above what we typically see on these types of debt transactions. They're priced over SOFR, which has been effectively at zero for a little while. It's been negative. And another system is challenge for bankers. They'll have a negative index to add to their for the next year but they can charge between two and a half and 4% over SOFR. So there's 150 basis points of wiggle room on that spread that that can be negotiated.

Then when they sell the 95% to the fed, they have to pay 1% of that sold amount as what's called a facility fee. Slightly a confusing language, but it says on there you can pass that along to the borrower. So in effect, you could charge them 1.95% of the balance as an origination fee. You keep one pay the 0.95 through to the fed and you just loaned them the money, be able to cover it.

So you could do it that way. I doubt many banks do it that way, but it's possible. So all that said, and again, those are unsecured. If you do the expanded facility, you use the collateral that you have on the existing structure and it's a pro rata share with the fed. So you dilute your collateral quite a bit, but you don't owe the facility fee. So there's differences between the two programs.

The bottom line is that even at the minimum spread levels, the way we measure it, these are profitable deal. So the other use case for those, I think beyond just de-risking is I think there's the possibility that some banks will use this as a way to gain some market share. So again these are pretty valuable customers that have a pretty high cost of acquisition typically, banks spend a lot of money trying to get their foot in the door with these types of customers because well beyond the credit relationship, there's all kinds of other potential revenue, from their deposit balances and their treasury services and ACH originations and lockbox services, all the things that these sorts of businesses use it's such that a lot of banks will actually use the credit as a loss leader.

They will break even or sometimes not even that on the loan facilities to try to cross sell everything else. So I think there will be some banks out there that take the long view of this and say, let's go find some businesses that we think are good, solid, longterm potential customers and let's be the Knight in shining armor and come riding into their rescue, let the fed take most of the risks and we offer them a loan that that earns all the trust and Goodwill that goes with it and saying, hey, we know times are tough.

Here's $10 million to help you through, and 95% of that exposure goes to the fed and then you can spend the next couple of years, converting them to kind of the full blown customer but that's your way in. So I don't think that'll be the primary use, but I think there will be some of that out there. And I think that's actually a pretty smart play.

Again, you have to be very selective with that, but you know your top 10 targets that you've been wanting to get a shout out, here's an unforeseen opportunity to maybe make that happen and build trust in a way that just cold calling somebody you're never going to be able to do.

Jim Young:

Yeah, that's interesting. It speaks, it kind of jogs two things in my mind. One is we talked a little bit, I think again the weeks all blend together at this point, but I believe we talked recently about sort of the flack that Bank of America and some of the other banks were taking for basically saying, hey, with PPP of we're going to address our current clients and then we'll get to everybody else.

Well, what you just outlined is an absolute reason for why you would want do that because as you mentioned, expanding market share, that sort of thing. If I tell you well hold on a second, I know you're a client, but I've got to deal with these five other people and then someone else comes in and says, hey, you can have this thing right now. Well the loyalty only goes so far with that and on the flips on the other part of that if you are, even if it is your current client, if you're not dealing with them fast enough then it could really do some damage.

And there was a wall street journal article I believe came out today about that talking about some of the issues that happened in bank and I won't bring it up on here, but you can look up the article and see it, they basically decided that they should try to create a portal in which and by the time they got the portal set up, the money was gone. So that a lot of irritated clients now that are available for the picking for other banks out there.

Dallas Wells:

Yeah, I think you're exactly right. And you can participate in both PPP and the main street facilities and I think there's going to be less of a stampede for the main street stuff. So I think there will be some banks out there that there's businesses with pending applications for PPP. They're buried in somebody's backlog and they may be 30,000 applications deep.

And maybe they'll get to them before the forms run out maybe they won't but you've got some business owners that are sweating bullets hoping that that happens. If you can be proactive and fast moving and say, hey it's not PPP but I have something that can help and it doesn't preclude you from taking the PPP if that happens to work out. I think that's a pretty powerful strategy that can be pretty helpful to a business and also will foster a great long term relationship.

Jim Young:

Yeah. And even if you're not that the example I mentioned was PPP but even put, if it's just main street, you haven't participated in PPP time is of the essence for everybody in this. And so if you're a bank, you have to have some systems hopefully you've already thought about this, but to get these things turned around quickly all at this sort of thing. So we talked about PPP, Main Street is this, Dallas, is this the last of our podcast explaining government, federal emergency loan programs?

Dallas Wells:

Sure doesn't feel that way.

Jim Young:


Dallas Wells:

I think the fact that as we record this, we're talking about Congress just getting to passing another round of PPP because the first one ran out so quickly and what the banks are forecasting I think we'll know where this stands by the time you're listening to this, is that just given the backlog and the fact that they've been able to catch their breath a little bit on processing these things, as soon as SBA opens the flood Gates again, you've got maybe 48 hours before PPP is gone again.

So I think there will be possibly additional extensions of that. There's some lobbying groups that are saying, hey, we might need $1 trillion worth of PPP kind of stuff and I just don't think Congress has the appetite for that sort of thing. So what that means is that there will be maybe variations of the main street program and I think there's, kind of second, third and fourth waves of economic follow up yet to come.

We're just starting to hear some of the early things about state and local governments who have no choice but to run balanced budgets are starting to have to send people home and starting to appeal to the federal government for some help. There are some related to the main street loan program that was a total of 2.3 trillion or $2 trillion of additional stuff, some of which included, municipal lending programs.

Some of those had some strange restrictions. There were some commercial paper funding facilities. So I think there's a lot more of this kind of alphabet soup type of programs coming our way. And we could be at this literally for years as we kind of deal with the follow-on effects if there does happen to be follow-on virus affects too. I know there's a lot of people hoping that this, we're just about out of the woods on this.

I think even if the virus part has done the economic part is not, so bankers have a lot of this left to do digesting these sorts of programs, who qualifies, who doesn't, how do you get them out the door, how do you service them? It's a weird thing that's come about where the federal government is trying to offer help but they're using the banking system as a conduit cause it's the only way they can kind of get money out the door.

And so banks are kind of playing middleman with having to figure out how to process all this stuff.

Jim Young:

Yeah. And thoughts on how to navigate I don't know. I looked at this question early on going into this and I was like, Holy cow, good luck answering this one but on navigating, how to navigate all this complexity cause we kind of talked about the dangers of being kind of too fast and too sloppy and the other ones that tried to be too meticulous and too slow.

Dallas Wells:

Yeah. So Carl Ryden at PrecisionLender always has a list of books that he's recommending and one that's been on there for the last good while for anybody who asked or any new employee is the checklist manifesto. So it's the concept of complicated processes and kind of the inability of humans to be able to navigate those as well as we showed our brains are just not geared to do it.

So things like flying an airplane, doing surgery and it's not about incompetent humans. Those are both highly trained professionals that do those things and there's lots of other systems checks involved, but they've gotten back to using good old fashioned paper checklists or sometimes in surgery I've seen in surgery rooms, sometimes it's painted on the wall. And the checklist is surprisingly simple like step one will be introduce yourselves.

So that in the middle of the surgery as things go array you know the name of the person across the table that you might need to ask for something but I think banks are facing that similar sort of thing where you've got potentially once all this stuff gets spun up, you've got maybe a dozen programs going at once, all being administered by the federal government, which means there's for each one of those dozens to hundreds of pages of rules and regulations and ways that a borrower qualifies or doesn't.

And if they already used this one, they can't use that one. It starts out as a reasonably simple checklist and then it gets really complex really fast. So our view of this and the way that we're trying to help clients navigate this is to try to build some really smart checklists for this.

So if we can see what you're doing with a customer, we can narrow down which checklist you should be on, help you walk through it for that particular deal and quickly triaged something to the right place. I think that's the only way that banks can navigate already between PPP, two different main street facilities, some other SBA programs, and then a bank internal forbearance programs that they've also put together.

You're already talking about six things, all of which are pretty complicated and all you have is a borrower on the phone to your relationship manager who's probably sitting in their living room with a kid crawling all over them and they're saying, I need $1 million to survive, what help can you give me? And you have to sort that into the right bucket and then quickly get it processed so that they survive.

It's a big ask and I think that's what banks you're going to have to try to do is treat it like you're flying a Boeing 737 right? Get off the checklist, figure out what needs to be done, where do they sit, make sure everything gets checked so that the bank stays whole as you use some government help and you've got to do it all quickly. So back to simple to navigate the complex. I think that's probably the answer.

Jim Young:

Yeah. And to end this on a slightly optimistic note on that, if you've ever been into the cockpit of one of those planes, it is overwhelming the number of buttons and knobs and everything else there and the thought that a human being could look at that and be able to manipulate it to navigate a plane is into the air it's almost preposterous, but you do it via those checklists.

And again, these federal programs are probably equally overwhelming to a lot of bankers out there but if you can come up with those checklists, which banks know how to do, they can pull this, pull that off and then they can navigate through this. I think that checklist is, makes a lot of sense. All righty. So again, this episode, like the previous ones in the last couple of weeks have come from questions that we're getting from our clients.

If you've got questions you want us to take a look into or just kind of take the time to sort of explain our views on it, please send me an email. Again, it's initial and that'll be in the show notes as well and that'll do it for this week show. So thanks again for listening or a few friendly reminders if you want to listen to more podcasts, check out more of our content.

You can visit our resource page at or you can head over to our homepage to learn more about the company behind the content. And if you like what you've been hearing, make sure to subscribe to the feed in iTunes, Google play, Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this is Jim Young for Dallas Wells and you've been listening to the purposeful banker.

About the Author

Jim Young

Jim Young, Director of Content at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career Jim has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender, he manages the many ways in which the company shares its philosophy on banking and the power of relationships. Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.

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